Sunday, June 27, 2010
New Blog Post: THE IRS HATES YOUR FAMILY......limited partnership.
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Monday, June 21, 2010
This is a great example of how a Real Estate Attorney can mess up an Estate Plan
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Tax Court Memo 2010-104: A New
IRS Tool for Valuing Gifts of Undivided Interests in Real Property
The facts are as follows. In 2000, the Ludwicks purchased unimproved real property in Hawaii.
By 2003 they had constructed an 8000-square foot vacation home. In December 2004 they established separate QPRTs, and
in February 2005 they transferred their respective undivided one-half ownership interests to their respective QPRTs.
At that time the property had a fair market value of $7.25 million and annual operating costs of approximately $350,000.
On their 2005 gift tax returns each spouse reported a gift of $2,537,500, reflecting a 30% discount for lack of control and
lack of marketability. On audit, the IRS allowed a discount of only 15% and assessed a deficiency, which led to the
Tax Court action. At trial the taxpayers' expert concluded that a 35% discount should apply, while the IRS expert testified
in favor of an 11% discount. The court rejected both experts' testimony and determined - using its own formula - that
a discount of 17% was appropriate.
A key element influencing this decision was the tenancy-in-common ("TIC")
agreement between husband and wife.1 As
described in an article authored by the taxpayers' expert after trial,2
the TIC agreement was properly executed and contained standard provisions, but included two sections that
directly impacted valuation and that are not typically found in the same agreement. One section prohibited either co-tenant
from seeking a partition of any part of the property, but another section gave each tenant the right to sell its undivided
interest to the other co-tenant at a pro rata value of the whole or, alternatively, to sell the property in its entirety.
Not surprisingly, the taxpayers' expert argued that the provision prohibiting partition took precedence over the forced sale
provision, and the IRS expert argued the opposite. The taxpayers' expert states the following about what occurred at
trial on this point: "With minimal discussion about the TIC Agreement at the onset of trial, the parties agreed
that a forced sale was indeed possible under the TIC Agreement. With no further discussion of the TIC Agreement, Judge
Halpern appears to have equated the forced sale provision to a partition right, thereby giving each co-tenant the unrestricted
right to force a judicial partition of the property."3
There is ample authority that restrictions in a TIC agreement (such as the waiver of the right to partition) support
significant discounts - often well in excess of 35% - because of their effect on marketability and control. But the
opinion focused primarily on a partition analysis in determining the value of the gifts. Another important factor in
this case is that Judge Halpern found both experts' testimony woefully insufficient. This created a vacuum to which
Judge Halpern responded with a formula. He determined how to apply the formula to the facts, using some of the experts'
data but developing his own as well. The result was a formula that started with the fair market value of the property,
then applied factors such as (1) a buyer's expectation of a 10% rate of return (discount rate), (2) a projected partition
period of two years (including a selling period of one year), (3) operating costs of $175,000 per year, (4) partition costs
of $36,250 per year, and (5) one-half of the projected selling costs. The calculation was further refined to take into
account Judge Halpern's determination that there was only a 10% probability that partition would be required, to produce a
This case is distinctive in the degree to which the court provided a well-expressed
formula by which to determine the value of the gift, making several assumptions necessary to the computation. The formula
and its detailed application - and of course the government-friendly result - are what will make this case so useful to the
IRS in future disputes. As such it is a lesson to estate planners, both when structuring transactions and later when
No issues appear to have been raised with how the transaction was structured, other than the use of apparently inconsistent
clauses in the TIC agreement. On the one hand the parties agreed to waive their rights of partition, but on the other
they agreed that either could force a sale of the property. According to the taxpayers' expert, the court seems to have
viewed the mechanism allowing either investor to force a sale as "providing a virtually risk-free liquidity option"
4 for that investor. However, in the expert's view,
the court gave no consideration to the fact that under either scenario (being able to force a partition, or force a sale)
the investors would "give up their ability to enjoy the amenities of a luxury vacation home without the ability
to replicate the existing benefits at one-half the cost; reason that could significantly increase the likelihood of a vigorously
Defending: Judge Halpern criticized both experts for failing to provide
enough relevant data to support their conclusions. He faulted the taxpayers' expert for the following: (1) analyzing
discounts in 69 undivided interest transactions but failing to include information about the underlying fair market value
or comparables of the properties in those transactions, and the standard of deviation among them, and (2) using income-producing
properties (and cashflow data) as comparables, when the property at issue was not a revenue-producing property.6 Judge Halpern also criticized the IRS expert for: (1) using sales
of commercial properties in the eastern United States as comparables, (2) relying on surveys from California real property
brokers but no underlying data about the transactions upon which the brokers based their responses, (3) using surveys regarding
pooled public TIC interests, which the expert himself even conceded were critically different from the property at issue,
and (4) relying on a review of tender offers for majority interests in public companies, and control premiums, which the court
dismissed as "unhelpful."
The respective experts' input was unhelpful to their cases in the following additional
(1) The taxpayers' expert failed to convince the court that a buyer would consider
more than just the cost of partition and the marketability risk; in fact, the opinion quotes some of his trial testimony that
seems to have conceded the IRS viewpoint. The court reasoned from this that "a buyer with a right to partition
could not demand a discount greater than (1) the discount reflecting the cost and likelihood of partition and (2) the discount
representing the marketability risk because, if he did, another (rational) buyer would be willing to bid more. That
iterative process would drive the discount down to the discount reflecting the expected cost of partition and the marketability
The taxpayers' expert and the IRS expert provided differing estimates on the costs of a contested partition. The court
adopted neither, instead finding that a contested partition would take two years to resolve (including one year to sell the
property) and that the costs made necessary by the litigation would be 1% of the value of the property. If the taxpayers
had been able to prove higher costs of a partition action, the value of the gifts might have been reduced.
(3) The taxpayers did not meet their burden of proof to show that partition would always, or even often, be necessary.
In fact, when IRS counsel suggested that partition was "relatively unlikely," the court notes that the taxpayers'
expert seemed to agree.8 From this testimony the court
determined that a buyer would expect partition to be necessary only 10% of the time. If the taxpayers had been able
to prove a higher likelihood of partition, the probability rate used in the court's calculation would have reduced the value
of the gifts.
(4) The taxpayers' expert and the IRS expert provided differing estimates of
the cost of selling the property. The court chose neither, finding that the selling cost would be 6% of the value of
the property. With the right facts it might be possible to project a higher selling cost, thereby decreasing the value
of the gifts.
(5) The IRS expert testified that a buyer would demand a 10% rate of
return to account for the marketability risk; the taxpayers' expert testified that a buyer would demand a return of 30%.
The court stated that the taxpayers' expert presented no evidence to support his conclusion, and therefore the taxpayers failed
to meet their burden of proof that anything greater than a 10% rate of return would be expected. Again, if the taxpayers'
expert had been able to produce credible data to support a higher expected rate of return, this might have reduced the value
of the gifts.
Working through the elements of Judge Halpern's formula, it is clear that if the taxpayers had been able
to meet their burden of proof as to various elements of the court's formula, the computation would have changed and the taxpayers
might have enjoyed an overall discount greater than 17% on the value of their respective gifts. This makes it difficult
to predict how Ludwick will apply in cases with different facts, but certainly it provides a framework for how other
valuation cases might be analyzed.
Commentators have noted that it is not clear in the Ludwick case whether
the result of focusing on the relatively minor costs associated with an uncontested sale of the property is a consequence
of the TIC agreement at issue, or a new line of thinking put forth by Judge Halpern for any undivided interest valuation where
a co-tenant retains the right to force a partition. Either way, from a planning perspective, the best advice for avoiding
a similar result is to engage knowledgeable attorneys and appraisers when structuring a gift of undivided interests in property.
Also, as the Ludwick case shows, if the parties wish to waive their right to partition, the waiver should be given
overriding importance in the TIC agreement, and decisions about whether to allow either party to force a sale should be carefully
considered. Should a valuation dispute arise, experts should be engaged who can heed the lessons of Ludwick
and produce data that will keep a court from embarking on its own valuation.
Morrison & Foerster's Trusts
and Estates group provides sophisticated planning and administration services to a broad variety of clients. If you
would like additional information or assistance, please contact Patrick McCabe at (415) 268-6926 or PMcCabe@mofo.com.
Copyright 2010 Morrison & Foerster LLP. This article is published with permission of Morrison & Foerster LLP.
Further duplication without the permission of Morrison & Foerster LLP is prohibited. All rights reserved.
The views expressed in this article are those of the authors only, are intended to be general in nature, and are not attributable
to Morrison & Foerster LLP or any of its clients. The information provided herein may not be applicable in all situations
and should not be acted upon without specific legal advice based on particular situations.
Presumably husband and wife entered into the TIC agreement in their capacity as trustees of the QPRTs.
"TAM 9336002 Bites Taxpayer," Carsten Hoffman, FMV Valuation Alert dated May 12, 2010.
 The dismissal
of income-producing properties and cash flow statements as comparables seems harsh. Even though the Ludwicks testified
that their property was not intended to produce income, this does not preclude the possibility that it could be used to produce
income at a future date.
 Ludwick v. Comm'r, T.C. Memo 2010-104, §A.2.
Wednesday, June 16, 2010
Title insurance purchase is simply not optional in Hawaii. You must buy it!
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is among some of the closing costs
that Hawaii Homebuyers may not be aware of, even though without it you are opening up yourself to huge risks.
Imaging being presented with a default notice on a home equity loan.
However, the you never had such
a loan, nor did you have any history with the bank that issued the notice. The problem is that previous owners could
have obtained a second mortgage on the property before selling it to you, and then made false statements to a title company.
What do you do?
Well without title insurance you are SOL, but with Title Insurance, you can tender the
claim and the title company should pay the bank and sue the old homeowners for fraud. Voila! you got
to keep your home without paying any extra costs, thanks to the title insurance.
So...title insurance is one
of the most important ways to safeguard a homeowner.
Title insurance insures the ownership of your home from the
day you buy it backwards. It insures you against past illegal acts or negligence.
In this economic climate watch
out for the properties that are owner financed, often buyers don't want the expense or simply don't know about
purchasing title insurance. With seller financing and no Escrow and Title, title insurance will not be required.
Please bother to get your own coverage, a title company can find undisclosed liens, saving the
buyer time, money and the pain of litigation.
I often get random requests for drafting of deeds and mortgage documents or agreements of sale in non-escrow real
estate transactions and I always ask if there is an ALTA policy for the lender or if the buyer will be purchasing
Saturday, June 12, 2010
Confusion Over the Dormant Estate Tax Keeps Advisers Busy
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New York Times: Wealth Matters
Published: June 11, 2010
has all of this affected your planning?
Steven H. Goodman, an accountant and financial planner in Melville, N.Y., says he has not had a meeting recently without clients asking him what they need to do this year and for
2011, when the tax is set to return at a higher rate than when it expired. Yet for all the business this has brought his firm,
the SHG Financial Group, Mr. Goodman says he is not happy. “It’s a pain in the neck,” he said. “Even
though I do this for a living, no one likes to do this.”
Those who work with the extremely rich say they, too,
have been exceedingly busy, but for a different reason. The wealthiest are looking to take advantage of a short-term trust
that allows people to pass money to heirs tax-free — what’s known as a grantor retained annuity trust —
out of fear that the federal government could change the terms of these trusts. Cheryl E. Hader, a partner in the individual
clients group at Kramer Levin Naftalis & Frankel, said she set up 30 of these trusts last month, up from six in a normal
month. Daniel L. Kesten, a partner in the private client group at Davis & Gilbert, a law firm in New York, said he was
working nights and weekends last month setting up the same type of trusts.
How this boon to tax advisers happened is
yet another chapter in the partisan gridlock common to Washington these days. At the end of 2009, Max Baucus, the Montana Democrat who is chairman of the Senate Finance Committee, tried to extend for three months the existing estate
tax laws, put in place in 2001. But when that motion failed, the estate tax expired for the first time since 1916.
this has meant is that the heirs of wealthy people who die this year will owe no taxes. An extreme case, as detailed in an
article in The New York Times on Tuesday, is that of Dan L. Duncan, who died two months ago with an estimated wealth of $9
billion. His heirs will inherit his estate without paying the 45 percent tax that was in effect in 2009, billions that would have gone to the Treasury.
it is possible that next year will bring cases of the other extreme, when the amount exempt from the federal estate tax falls
to $1 million, its 2001 level, from $3.5 million in 2009, and the rate rises to 55 percent, from 45 percent.
Duncan dies and pays nothing, but the guy who dies with his house worth $2 million next year and his estate is going to pay
$550,000,” said Lance S. Hall, president of FMV Options, a firm that values estates. “Is that fair?”
there were rumblings at the beginning of the year that Congress might reinstate the estate tax and make it retroactive to
Jan. 1, it has made no progress on the issue. And the death of someone as wealthy as Mr. Duncan makes a retroactive tax unlikely.
“Now we’re way beyond that consideration,” Mr. Kesten said. “This single family could outspend
the I.R.S. in litigating this.”
So what will happen? If Congress does not reinstate the estate tax this year,
2010 could be a bonanza for the nation’s richest. The short-term grantor retained annuity trust, whose possible end
is separate from the fate of the estate tax, is one option. But other families are simply taking advantage of the lowest gift
tax rate since 1933, 35 percent, to pass millions to their heirs.
The real problem comes for the merely rich —
individuals worth more than $1 million and less than $3.5 million and couples with net worths of $2 million to $7 million
who previously did not have to worry about the estate tax. If Congress fails to act again this year, the estate tax laws next
year will revert to their levels before 2001, and that could snare a host of people who set up the estate plans on the assumption
that there would be no tax when they died.
“If Congress does nothing, there would be a sevenfold increase in
the number of estates subject to the tax than if the exemption stayed at $3.5 million,” said John Dadakis, partner at
the Holland & Knight law firm.
As the law stands, the heirs of a single person who dies next year with more than
$1 million would be subject to a 55 percent tax. (For couples, it is $2 million.) Heirs of that same person, with a $3.5 million
estate, would have paid nothing in 2009 but could pay as much as $1.375 million in 2011, depending on the level of planning.
And while this wealth may seem high in many parts of the country, it has professionals on the coasts grumbling.
the Northeast, where people own their own homes and have owned them for decades and have money in their retirements, there
tend to be a lot of millionaires,” Mr. Kesten said. “It would sweep a whole chunk of the upper-middle class into
what used to be a fairly elite group.”
How has all of this affected your planning?
The only upside to the return to the 2001 level is clarity. Having no estate tax this year is saving
wealthier people a lot of money, but at the cost of an added layer of complexity for both them and for many people who would
not have had to worry about the estate tax.
That’s because the assets of people who died under the old estate
tax regime were valued at the date of their death for tax purposes. Any capital gains on, for example, stocks purchased decades earlier — which would have been subject to tax if sold — were erased. That is no longer the
case, and figuring out what is owed requires determining the original purchase price — however long ago that was.
an estate tax this year, the Internal Revenue Code grants an artificial step-up in basis, as it is called, of $1.3 million
to be used at the executor’s discretion and $3 million on assets passed to a spouse. The only glitch is the Internal Revenue Service has yet to issue documents to record how this exemption has been applied.
“The absurdity of it all is there
is not even an I.R.S. form yet to do this,” Ms. Hader said. “My client who died on Jan. 2. Even if we wanted to
comply with the law as it exists now, we can’t.”
“We are aware of the increasing need for direction
from the I.R.S. on this issue,” the agency said in a statement. “We will be working closely with the Treasury
Department to provide answers as quickly as possible, and, if necessary, to develop a new form.”
While the tax
would not be due until April 15, 2011, the problem comes when heirs need to sell something. If they received a long-held position
of stock, they might want to sell part of it to diversify their holdings or raise cash. But they would incur a 15 percent
capital gains tax on the appreciated amount.
It is trickier for property. John Nuckolls, national director of the private
client tax services practice at the accounting firm BDO, said a friend in Iowa inherited a farm from his mother that he wanted
to sell. With a basis near zero, it was worth more than the $1.3 million that the I.R.S. step-up in basis would exempt but
less than the $3.5 million exemption in 2009. If he sells it this year, he will incur capital gains tax.
But that is
little compared with what heirs to a moderately wealthy person may pay if Congress does not act.
Friday, June 11, 2010
What is a Self Directed IRA with LLC (ICO)?
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The Self Directed IRA LLC (ICO)
With this option, you open an Self Directed IRA account and then
we create a separate LLC that your IRA will invest in. This LLC can have a checking account setup. You, the IRA account owner,
will be the manager for the LLC and as such you will have administrative powers and control over the asset and/or checking
This account setup allows you to have the necessary powers and control over management of the IRA's assets.
This account setup is ideal for clients who need to hold real estate for investment purposes and may need to pay bills and
expenses related to the property or any other asset. As the manager of the LLC you can buy and sell assets at your discretion.
A Self Directed IRA's ownership of a LLC, referred to after this as "ICO" ("I"RA
"Co"mpany), is a special purpose limited liability company, which is either fully or partially owned by an IRA (Individual
Retirement Account). Since the self directed IRA owns the ICO, IRA funds can be legally transferred to the ICO in exchange
for member units (shares) of the ICO. After this funding, both traditional and non-traditional investments may be purchased
by the ICO instead of directly in the IRA.
Self Directed IRA Benefits:
- An ICO allows you to hold
real estate or other non-traditional investments in an IRA with checkbook control. Very few IRA custodians permit direct ownership
of real estate or other non-traditional investments in an IRA, so indirect investment via the ICO is usually the only choice.
the ICO sells real estate or other investments, the capital gains are deferred through the IRA, like any other IRA investment.
The headaches of 1031 exchanges are never necessary.
- Ownership of the property in an ICO allows you, as manager,
to have direct, hands-on control of and investment decisions over ICO assets, including control of the checkbook. Custodian
involvement and hassles are eliminated, regardless of whether the investments are in securities, real estate or other assets.
ICO can use its IRA funding as a down payment for a real estate purchase, with the ICO financing or borrowing the balance.
But an IRA cannot directly participate in such a financing arrangement.
- Since you control and handle all ICO transactions,
the custodian for the IRA can be paid an inexpensive, flat fee, typically under $200 per year
- Litigation threats which
accompany investments such as real estate are substantially reduced. This is done by isolating the investment inside the ICO,
and away from the rest of your IRA funds and estate.
- Continues to provide deferral of income and gains inside the
- Setup of LLC
- Filing of state articles
- Filing of Tax Identification
Number with the IRS
- IRA, prohibited transaction compliant operating agreement
- Setup and operating guide
authorizations for checking account
How It Works
- Setup of LLC
- Setup a IRA custodian who handles
self directed IRAs
- Create the LLC - You can operate as the Manager.
- Transfer IRA to custodian
checking account at a local bank
- Direct the ira custodian to transfer money to LLC in the form of purchasing membership
units in the LLC
- Direct investments from the LLC
- Real Estate
- Hard money
- Precious Metals (Gold, Silver, Platinum)
- Private placements or offerings (oil & gas, real estate,
- Foreign Real Estate
- Funding a business
- Trust deeds
- And Many Others!
The use of a qualified IRA custodian is required to complete this process.
Wednesday, June 9, 2010
Irrevocable Life Insurance Trust
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The irrevocable life insurance trust (ILIT) provides an accessible means of avoiding
estate taxes on life insurance proceeds. The potential savings may outweigh the disadvantages of what you have to give up.
Basics of Life Insurance and Estate Tax
tax is a tax on the transfer of property at your death. Life insurance proceeds are among the types
of property that are subject to estate tax. However, depending on the size of your estate, you may not even have to pay estate
Estate taxation of life insurance proceeds centers around ownership of the policy
and payment of the proceeds. If the proceeds of a policy are paid to the insured person's estate, then they will be fully
subject to tax on the insured person's death.
If you own a life insurance policy, upon
death, your estate will be fully subject to tax if (1) the proceeds of the policy are payable directly or indirectly to your
estate, or (2) if you, while alive, held any ownership in the property, such as the right to charge a beneficiary, surrender
or cancel the policy or borrow against the policy.
If you have an life insurance policy
covering you and you do not own it, then the proceeds of the policy will not be subject to estate tax. It is not unusual for
an insurance policy to be taken out on someone else. However, beware that if you don't own the policy, you
can't make any changes to it or cancel it.
If you leave life insurance proceeds to someone
other than a spouse, such as a child, relative, or friend, the proceeds will be taxed as being part of your estate.
On the other hand, if you leave life insurance proceeds to a spouse, the proceeds will not be subject to your
estate at your death, but the surviving spouse's estate may be taxed.
An Irrevocable Life Insurance Trust ("ILIT") offers the opportunity of escaping
taxes not just in one estate, but in several estates. The ILIT is typically a trust for the benefit of the spouse and/or children.
An life insurance policy that is placed in an ILIT is considered to have no owner. Thus, once placed in an
ILIT, you do not have the power to change or cancel the life insurance policy.
If you already
has a life insurance policy, ownership of the policy can be assigned (transferred) to the ILIT. This is done by signing an
irrevocable assignment form available from the insurance company or from the agent. Proper completion of the form will indicate
that the ILIT will be the new owner and the beneficiary.
Take note, however,
that if the insured/transferor dies within three years of the date from which the policy was transferred, the life insurance
proceeds will be included in his estate for tax purposes. This does not mean that the beneficiary will not receive the money,
it merely means that your estate will have to report the proceeds as being part of your estate when computing the estate tax.
For this reason, where the insured has a spouse, the ILIT should usually contain a fail-safe clause, providing
that if the insured/transferor dies within three years of the transfer of any policy to the ILIT, then the proceeds of such
policies will be held separately under the ILIT and administered for the surviving spouse in a way that will qualify for the
estate tax marital deduction.
This arrangement will render those proceeds tax free if the
insured dies within three years and is survived by is spouse. The trade-off is that whatever is left of these proceeds will
then be included in the estate of the surviving spouse.
If the insured dies after a crucial
three-year period, the fail-safe clause would not apply and the entire trust could provide for the family.The three-year concern can be completely avoided if the policy is purchased at the outset by the trustee of
the ILIT. This way there is no policy transfer, so no three-year period to worry about.
For Your Attorney
- How do I create an ILIT?
I have to go through my insurance company to create an ILIT?
- Will my estate be subject
to estate tax when I die? Will my life insurance proceeds?
Sunday, June 6, 2010
Study Shows Family Businesses Not Implementing Plans
Excerpted from http://biz.yahoo.com/prnews/080611/clw030.html?.v=101
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According to a study
sponsored by U.S. Trust, owners of ultra-high-net-worth (UHNW) family businesses remain exposed to business succession, asset
protection and estate planning issues.
"Owners of ultra-high-net-worth family businesses often have a team
of advisors focusing on an array of needs such as wealth management, tax strategies and succession planning, without addressing
the bigger picture," said Chris Zander, managing director and head of the Multi-Family Office (MFO) Group at U.S. Trust.
"Given the near-term and long-term complexities with managing a successful family business, it is crucial that these
families think about the wealth tied to their business and their personal fortune in a holistic, strategic manner."
The study revealed that while a large majority of owners of UHNW family businesses have wealth transfer plans in place,
most of these plans - both professional and personal - have lapsed.
-- While over three quarters (76%) of owners
have succession plans, only 38 percent implement them, inadequately addressing issues of succession
-- Most individuals
with succession plans in place are not focusing on tax-mitigation issues (73%), even though nearly all participants (93%)
report a desire to lower the tax burden associated with transferring the business
Asset Protection Strategies Missing
A significant portion of owners of UHNW family businesses desire to maintain control of the business and are concerned
with protecting their wealth, yet fail to create asset protection plans, which provide wealth structuring strategies that
maximize tax efficiencies and mitigate risk.
-- Almost nine out of 10 (89%) business owners were "very"
or "extremely concerned" about protecting the family's wealth
-- However, nearly three quarters (73%) of them
do not have asset protection plans in place
"Most owners of ultra-high-net-worth family businesses don't implement
strategies for asset protection in large part because no one has educated them about such options," Rosenthal noted.
Estate Plans Outdated
The treatment of estate planning mirrors that of succession planning, with the majority
of owners creating estate plans without updating them often enough to keep them viable.
-- Over three quarters
(78%) of owners have personal estate plans; however, 89 percent have not updated them after a life-changing event such as
marriage, birth or death rendering the plan obsolete
-- More than half (54%) of participants lacking estate plans reported
difficulty dealing with their own mortality, and one quarter (25%) cited a lack of time as reasons for not creating a plan
With the upcoming elections and the tax-fallout many professionals are expecting, and with the already-enacted estate
and gift tax sunset approacing, updating and implementing business succession plans, personal estate plans, and asset protection
plans take on a new significance.